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The Conservation Crossroads in Agriculture: Insight from Leading Economists

Economic & Environmental Effects of Agricultural Insurance Programs

by Daniel A. Sumner University of California, Davis and Carl Zulauf Ohio State University July 2012

Contents Executive Summary 1 Introduction 3 Recent Evolution of Crop Insurance in the United States 4 Crop Insurance Principles 5 Crop Insurance and the Evolution of Farm Commodity Programs 7 Crop Risks and the Role of Government 7 Effects of Crop Insurance Subsidies 8 Summary and Conclusions 13 References and Data Sources 15 Dan Sumner is Director of the University of California Agricultural Issues Center and the Frank Buck, Jr. Professor, Department of Agricultural and Resource Economics, UC Davis. Carl Zulauf is Professor, Department of Agricultural, Environmental, and Development Economics, Ohio State University. The authors thank Joe Glauber, Barry Goodwin, and Keith Coble for helpful guidance and Jessica Vergati for exemplary research assistance.

More information is available at www.cfare.org Š2012 Published by C-FARE

Executive Summary Crop insurance has evolved over the past decade to become the most important crop subsidy program in the U.S. For fiscal year 2013, crop insurance programs are budgeted to account for about 63 percent of all crop subsidies. With the proposed elimination of the direct payment programs in all main Farm Bill proposals, crop insurance will serve as the primary subsidy for domestic agriculture. This paper provides a review of the core economic rationale for subsidies for crop insurance and a review of the economic literature associated with crop insurance programs. In addition, the paper examines how certain design elements of the insurance programs may result in less diversification of crops, planting in marginal land and the potential to increase the use of inputs while reducing certain risk mitigation practices. Included in the findings is that crop insurance seems to affect production in three primary ways:

1

Evidence-based analysis supports that subsidized crop insurance encourages the movement of crop production onto marginal lands and can result in environmental risks that would not

The subsidies raise the net revenue per acre and thereby raise incentives to plant eligible crops and plant more of crops with higher subsidy rates;

occur in the absence

The availability of crop insurance, which is made possible by the government program, encourages planting insured crops on fields that would not otherwise be considered for that crop because of the potential for significant losses; and

insurance.

By reducing chances of losses from low yields and prices, crop insurance creates incentives for growers to undertake fewer other risk mitigating practices and therefore focus more on increases in average productivity.

of subsidized crop

In a review of crop insurance and environmental quality, although research is not yet definitive, the paper points out, evidence-based analysis supports that subsidized crop insurance encourages the movement of crop production onto marginal lands and can result in environmental risks that would not occur in the absence of subsidized crop insurance. For example, a large study conducted by the Economic Research Service (Lubowski, et al.) found that: “Increased crop insurance subsidies in the mid-1990s motivated farmers to expand cultivated cropland area in the contiguous 48 states by an estimated 2.5 million acres (0.8 percent) in 1997, with the bulk of this land coming from hay and pasture. This land-use change increased annual wind and water erosion by an estimated 1.4 and 0.9 percent, as of 1997.”

Economic and Environmental Effects of Agricultural Insurance Programs

2

Regarding environmental consequences of subsidized crop insurance, the paper states that subsidies for crop insurance may affect environmental consequences through several channels including: •

Incentives to expand onto more environmentally sensitive lands;

Incentives to use more inputs as average returns rise;

Incentives to shift across crops toward those, such as cotton, that may have more negative environmental consequences;

Incentives to use fewer risk-reducing practices and materials; and

Impact from the lack of environmental or conservation compliance rules for crop insurance as have applied to land under the traditional crop subsidy programs.

Economic and Environmental Effects of Agricultural Insurance Programs

3

Introduction After a long history as a relatively small part of the U.S. farm program regime,

price-based programs, and Congressional

has served as both a stated rationale for

efforts to broaden the availability and

government-sponsored programs and a

attractiveness of federal insurance.

caution about whether demand by farmers for insurance against risks is as strong as

crop insurance has evolved over the

Economists have devoted substantial

past decade into the most important

attention to the underlying economic

crop subsidy. For fiscal year 2013, crop

rationale for government crop insurance

Policy issues associated with government

insurance programs are projected to

programs. Basic insurance issues are

insurance programs are (a) their public

account for about 63 percent of all U.S.

risk aversion, moral hazard and adverse

cost, (b) the supply response of farmers

Department of Agriculture’s budgeted

selection; as well as heterogeneity of

to insurance subsidies and impacts on the

outlays for farm subsidies (Figure 1).

often portrayed.

risk and correlation of negative shocks

quantity produced and thus on commodity

The dominant role of insurance reflects

over time and across policyholders. For

markets, (c) the geographic distribution

the impact of recent high prices, which

crop insurance, the lack of market-based

of subsidies and resulting impacts on

have eliminated payments from traditional

insurance at commercially viable premiums

spatial distribution of production, (d) the distribution of subsidies across farms and the impact on the size distribution of

Figure 1 Budgeted USDA Outlays by Commodity Programa, Fiscal Year 2013

farms, (e) environmental impacts, and (f) the potential effects on obligations under international trade agreements, including potential challenges in the World Trade Organization (WTO). Other issues include the impact on organic agriculture and

Crop Insurance 63%

production for local consumption.

Direct Payments 33%

This brief review cannot delve into all of these complex insurance and policy issues in depth. It will also leave aside technical

Other b 4%

elements that have been the focus of much of the academic literature. After a brief description of current crop insurance

a

Tobacco buyout transactions, milk program outlays and conservation programs are not included.

b

Other includes Marketing Assistance Loans; Countercyclical Payments; Loan Deficiency Payments; Cotton Payments; Noninsured Crop Disaster Assistance Program; Biomass Crop Assistance Program; Farm Storage Facility Loans; Purchases and Sales; Processing, Storage and Transportation; Bio-based Fuel Production; Operating Expenses; Interest Expenses and other smaller outlays.

Source: U.S. Department of Agriculture, Office of Budget and Program Analysis (2012). FY 2013 Budget Summary and Annual Performance Plan, U.S. Department of Agriculture. Accessed: http://www.obpa.usda.gov/.

programs and some recent data about the evolution of the programs, we will consider briefly the core economics of the rationale for subsidies for crop insurance. Then we will consider what the economics literature suggests about the implications of current agricultural insurance programs.

Economic and Environmental Effects of Agricultural Insurance Programs

4

Recent Evolution of Crop Insurance in the United States

the FCIC. RMA oversees the delivery of

and indemnities have increased about

programs by private insurance companies,

seven times to liabilities of $113 billion

sets premium rates, pays for operation and

and indemnities of $7 billion in 2011.

management of the program including farm

Premium subsidies have also risen to

Congress authorized formation of the

premium subsidies, and reinsures private

about $7 billion in 2011 (Table 1).

Federal Crop Insurance Corporation (FCIC)

insurance companies against losses.

in 1938. Crop insurance remained a small

Since 2005, covered acreage has stayed

program until the Federal Crop Insurance

By any measure the federal crop insurance

relatively constant as insured acres of

Act of 1980 expanded both the crops and

program has grown immensely since the

the large-acreage crops of wheat, corn

regions it covered. However, the modern

early 1990s. The number of separately

and soybeans have stabilized. However,

crop insurance program can be dated to

insured crops has increased from about

liabilities have continued to grow. The

the Crop Insurance Reform Act of 1994

50 to more than 300 depending on how

reasons are higher crop prices, extending

and the formation of the Risk Management

crops are categorized. Insured acres have

insurance to crops with a higher value per

Agency (RMA) in 1995 to administer

increased by 50 percent while liabilities

acre, and farmer decisions to buy higher

Table 1 Profile of the U.S. Crop Insurance Program, Selected Years, 1990-2011

a

Year

Total policies solda (million)

Buy-up policies sold (million)

Net acres insured (million)

Total liability ($ billion)

Total premium ($ billion)

Total indemnity ($ billion)

1990

0.89

0.89

101.4

12.83

0.84

0.97

0.86

1995

2.03

0.86

220.5

23.73

1.54

1.57

1.02

2000

1.32

1.01

206.5

34.44

2.54

2.59

1.02

2005

1.19

1.05

245.9

44.26

3.95

2.37

0.60

2006

1.15

1.03

242.2

49.92

4.58

3.50

0.77

2007

1.14

1.02

271.6

67.34

6.56

3.55

0.54

2008

1.15

1.03

272.3

89.90

9.85

8.68

0.88

2009

1.17

1.08

264.8

79.57

8.95

5.23

0.58

2010

1.14

1.06

256.2

78.10

7.59

4.25

0.56

2011

1.15

1.07

265.3

114.07

11.95

10.71

0.90

Catastrophic (CAT) policies, introduced in 1995, make up the difference between buy-up and total policies.

Source: U.S. Department of Agriculture, Risk Management Agency (2012). Summary of Business Reports and Data. Accessed: http://www.rma.usda.gov/data/sob.html.

Economic and Environmental Effects of Agricultural Insurance Programs

Loss ratio

5

coverage levels and revenue instead

receipts has increased from 0.1 to 0.2 in

difference between the loss amount and

of yield insurance (see Figure 2). In

the early 1990s to almost 0.6 in 2011

deductible. For example, if the deductible

1995, nearly all insured acres were at 65

(see Figure 3).

loss is 10 percent and the actual loss

percent or lower coverage, but by 2011

Crop Insurance Principles

revenue insurance has grown dramatically in popularity, adoption of revenue insurance has lagged in specialty crops. The inclusion of California in Figure 2 illustrates this point. To summarize the growth in crop insurance, the ratio of insured liability relative to U.S. crop cash

because it covers a range of events that

before discussing current crop insurance

may trigger low yields or low revenue,

issues in the context of recent economic

such as drought, frost, too much rain, etc.

literature. As with all insurance, crop

Multi-peril insurance is more costly than

insurance makes an insurance indemnity

insurance for a specific cause of a loss

payment when a loss exceeds the

because the potential for a covered loss

insurance deductible. Payment equals the

is higher.

Under Revenue-Based Policies, U.S., 1995-2011

90 United States

70 60 50 40 20 California

10

2011

2010

2009

2007

2008

2005

2006

2003

2004

2002

2001

2000

1999

1997

1998

1995

0 1996

Crop insurance is multi-peril insurance

A few concepts and principles are noted

Figure 2 Share of Buy-Up Liabilities

Revenue-based share of buy-up liabilities (%)

payment equals 10 percent.

Source: U.S. Department of Agriculture, Risk Management Agency (2012). Summary of Business Reports and Data. Accessed: http:// www.rma.usda.gov/data/sob.html.

Figure 3 Ratio of Total Liabilities to

Total U.S. Cash Receipts From Crops, 1990-2011

0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

at 75 percent or higher coverage. While

Ratio of liabilities to total crop cash receipts

about 75 percent of insured acres were

80

is 20 percent, the insurance indemnity

Sources: U.S. Department of Agriculture, Risk Management Agency (2012). Summary of Business Reports and Data. Accessed: http://www. rma.usda.gov/data/sob.html. U.S. Department of Agriculture, Economic Research Service (2012). Farm Income Data Files, Cash Receipts. Accessed: http://www.ers.usda. gov/Data/FarmIncome/finfidmu.htm.

Economic and Environmental Effects of Agricultural Insurance Programs

6

Because adverse

Two key issues associated with insurance

selection, think premiums are too high

are moral hazard and adverse selection.

(Babcock, 2012 and Glauber, 2004).

Moral hazard exists when insurance

These farmers are less likely to purchase

hazard increase

alters decisions of the insured in a way

crop insurance and this means that

expected insurance

that increases the probability of a loss.

premiums are higher yet.

selection and moral

Moral hazard is considered especially

claims, they must be

problematic in a complex process such as

built into premium

crop production. Farmers make a series of

rates and contribute to why some farmers, notably those with less moral hazard and adverse selection, think premiums are too high.

managerial decisions from planting through harvest that influence yield and include considerations of risk. Many of these decisions can be influenced by whether or not the farmer has insurance.

A standard tool used by insurance companies to manage moral hazard and adverse selection is a deductible. A deductible precludes payments on small losses, which are considered the losses most susceptible to either change in the management decisions because the farm has insurance (moral hazard) or are losses

Adverse selection exists when a potential

that the farmer knows more about than the

insurance customer knows more than the

insurance company (adverse selection).

insurance company about the probability and magnitude of loss relative to the premium. For example, a farmer may know that his crop yields have a higher potential for large shortfalls and that the premium does not fully reflect his/her higher downside risk.

Area-wide insurance is also used to address moral hazard and adverse selection. Halcrow (1949) pointed out that, when the cause of indemnities is outside the control of the individual farm, such as for insurance triggered by a countywide yield shortfall, the choice to buy insurance

Neither moral hazard nor adverse selection

is less influenced by adverse selection

implies fraud or other illegal or immoral

and the behavior after purchase is less

behavior. They simply reflect the impact

influenced by moral hazard. Miranda’s

that insurance can have on decision-

update (1991) of Halcrow’s ideas

making and differences in information

stimulated research on setting premium

known by the insured and the insurance

rates and other operational issues for area

company.

insurance (see for example, Skees, Black

Because adverse selection and moral hazard increase expected insurance claims, they must be built into premium rates and contribute to why some farmers, notably those with less moral hazard and adverse

Economic and Environmental Effects of Agricultural Insurance Programs

and Barnett, 1997; Miranda and Glauber, 1997; and Mahul, 1999.) However, areabased crop insurance has not had notable market success in the face of substantial competition from individual coverage at high-premium subsidies. According to

7

Since the New Deal,

data from USDA, RMA, county insurance

The geographical aggregation used to

products accounted for only 2 percent

measure shortfalls has received the same

of the total net acres insured in crop

economic analysis. As the breadth of

farm commodity

insurance during the 2011 crop year.

geographical aggregation decreases,

programs have

say from states to counties, program

provided benefits when

Crop Insurance and the Evolution of Farm Commodity Programs

cost increases because yields become

prices or revenues

more variable.

were low. At the same

programs have provided benefits when

Crop Risks and the Role of Government

prices or revenues were low. At the same

Businesses face risk that has both little

have provided

time, various programs have provided

correlation across firms (idiosyncratic

payments when farms faced widespread

risk) and risk that firms in the same line

payments when farms

losses on crop or livestock production.

of business tend to share (systemic risk).

faced widespread

The Food, Conservation, and Energy

Insurance is often easier and cheaper

Act of 2008 (2008 Farm Bill) authorized

for idiosyncratic risks, although adverse

losses on crop or

two revenue-based programs for the

selection and moral hazard remain issues.

program crops: the Supplemental Revenue

Systemic risk, which may generate large

Assistance (SURE) Program and the

indemnities at the same time, creates

Average Crop Revenue Election (ACRE)

incentives for larger and more diversified

program. ACRE enrollments were small

insurance companies or reinsurance with

and neither program is likely to survive in

firms that cover potential losses across

the 2012 Farm Bill. Programs similar to

several different lines of risk.

Since the New Deal, farm commodity

ACRE, which offer government payments to producers of program crops when area-wide revenue fall relative to some recent benchmark, have been favored by commodity groups. Such programs would replace payments based on planting history and those based on a national price trigger (Zulauf and Orden (forthcoming.) One set of simulations find that such programs could have high government budget costs under some circumstances (Smith, Goodwin and Babcock, 2012).

time, various programs

livestock production.

Systemic risk is important in most industries. For example, many industries face common variations in energy fuel prices, or recessions and fluctuations in exchange rates. Farming is also subject to considerable systemic risk. This risk arises in part from natural events such as frost, drought and excess moisture, both in the U.S. and internationally, and in part from variation in commodity prices and the prices of major production inputs.

Economic and Environmental Effects of Agricultural Insurance Programs

8

Farm returns are less correlated with

losses has not been available without

2007), and Sumner, Alston and Glauber

the rest of business than are most other

heavy government subsidy (Wright and

(2010). For application to the current

industries, as the farm revenue boom

Hewitt, 1994; Tweeten and Zulauf, 1997).

policy debate, Shields (2010) and Smith

of the past five years has shown. That

(2011) summarize useful facts and

Effects of Crop Insurance Subsidies

increases the opportunity for insurance companies to diversify across agriculture and other businesses. Of course, in most

perspectives.

Budgetary Cost of Crop Insurance

The crop insurance literature began with

industries, insurance for routine production

Valgren in 1922, but this brief discussion

and revenue variability is not common.

draws on Goodwin and Smith (1995),

Likewise, except for fire and hail insurance,

Knight and Coble (1997), and the more

insurance against farm yield and revenue

recent expositions in Glauber (2004 and

Government outlays for crop insurance have grown substantially over the past decade (see Table 2 and Figure 4). For the 2011 crop year, total government

Table 2 Income and Expenses of U.S. Federal Crop Insurance Program, Crop Yearsa 2002-2011

Crop Year

Farmer Paid Premium

Premium Subsidyb

Underwriting (Gain) / Loss

Total Incomec

Loss Claims Paid

Claims in Excess of Total Income

Administrative Expense Reimbursement

Total Government Costsd

$ Millions

2002

1,177

1,744

10

2,989

4,067

1,078

628

3,565

2003

1,393

2,061

-381

3,124

3,262

138

736

3,084

2004

1,720

2,481

-696

3,556

3,238

-318

894

3,200

2005

1,617

2,346

-915

3,097

2,370

-727

833

2,591

2006

1,906

2,687

-825

3,815

3,506

-309

962

3,465

2007

2,745

3,828

-1,574

5,045

3,551

-1,494

1,335

3,792

2008

4,171

5,696

-1,098

8,818

8,689

-129

2,013

7,717

2009

3,530

5,430

-2,277

6,750

5,234

-1,516

1,619

5,664

2010

2,891

4,714

-1,929

5,740

4,236

-1,504

1,371

4,724

2011

4,348

7,164

-1,007

10,585

13,103

2,518

1,383

11,209

Total

25,498

38,151

-10,692

53,519

51,256

-2,263

11,774

49,011

est.

a

Interest and other income, and other administrative and program costs are on a fiscal year basis. Remainder of the data is on a crop-year basis. May include additional subsidy from other sources. c Includes interest and other income. d Sum of premium subsidy, claims paid above income, administrative reimbursement, and other administration and program costs. b

Source: U.S. Department of Agriculture, Risk Management Agency. “About RMA: Costs and Outlays.� Accessed on June 22, 2012 at http://www.rma.usda.gov/aboutrma/budget/costsoutlays.html.

Economic and Environmental Effects of Agricultural Insurance Programs

9

Analysis has suggested

cost for crop insurance is currently

Most USDA reimbursement of insurance

estimated to exceed $11 billion. Since

company costs is calculated simply as a

the 2002 crop year, premium subsides for

percentage of premiums. But this makes

it would be more cost

farmers have accounted for approximately

sense only if premiums reflect costs of

effective, in terms of

three-quarters while reimbursements to

servicing a policy, and if premiums rise only

crop insurance companies account for

because of higher farm prices, insurance

benefits for growers,

about one-quarter of the government’s

company operational costs will not rise

to simply provide crop

cost. In recent years, farmers have paid

proportionately (Glauber 2007). Babcock

about 38 percent of the total premium.

(2012) has suggested it would be more

insurance for free,

This share has raised a question about

cost effective, in terms of benefits for

whether the demand for crop insurance is

growers, to simply provide crop insurance

being driven by the premium subsidy rather

for free, rather than subsidize the complex

than by risk management (Glauber, 2004;

system of administration and operation

of administration and

Goodwin, 2001).

of insurance companies. Free insurance

operation of insurance

rather than subsidize the complex system

companies. Figure 4 Total Federal Budget Costs of U.S.

Crop Insurance Program, Crop Years 2002-2011 ($ in millions)

12,000 10,000

$ Millions

8,000 6,000 4,000 2,000

2011 est.

2010

2009

2008

2007

2006

2005

2004

2003

2002

0

Source: U.S. Department of Agriculture, Risk Management Agency. “About RMA: Costs and Outlays.� Accessed on June 22, 2012 at http://www.rma.usda.gov/ aboutrma/budget/costsoutlays.html.

Economic and Environmental Effects of Agricultural Insurance Programs

10

would avoid adverse selection problems

A relatively early paper by Nelson and

operating loan defaults for lenders and

and reduce operational costs. More than

Loehman (1987) raised the issue that

others who finance crop production.

anything, the free insurance idea highlights

subsidized crop insurance may encourage

just how expensive the administration and

increased production. Subsidies for crop

operation of the crop insurance system has

insurance may affect production in three

become.

ways:

The budgetary cost of crop insurance

First, by compensating growers for losses

therefore focus more on increases in

naturally depends on the level of

and providing a subsidy in the process,

average productivity. When the grower

aggregation at which indemnities are paid

subsidized public insurance will increase

(or his banker) bears the full costs of

and premium rates are set. For example,

expected income per acre since farmers

losses, he has an incentive to devote more

Dismukes, et al. (2011) found that,

are not paying the full actuarial cost of

resources to reduce large potential losses

compared with the state level, a county-

the insurance. The higher expected (or

even at the cost of lower average output.

level revenue program would cost 28 to 32

average) net revenue should encourage

For example, subsidized crop insurance

percent more for wheat, cotton and grain

farmers to plant insured crops and plant

may encourage a grower to diversify less,

sorghum and 16 to 19 percent more for

more of the crops with higher subsidy

and invest less in risk-reducing inputs such

corn and soybeans.1

rates. In effect, it is reasonable to

as prophylactic chemical treatments for

hypothesize that subsidized insurance

potential pest outbreaks.

Year-to-year budget costs vary with crop prices and yields. In some years, such as 2009 and 2010, with very low loss ratios,

premiums will have effects similar to that of a price subsidy.

Third, by reducing chances of losses from low yields and prices, insurance creates incentives for growers to undertake fewer other risk-mitigating practices and

Relatively few studies have addressed these topics, and their findings tend to be

government costs are low. In years such as

Second, the availability of crop insurance,

specific to the region and crop examined.

2011 with indemnities, budget costs rise

which is made possible by the government

Wu (1999) found that Nebraska corn

(Table 1 and Table 2).

program, encourages planting insured

farms that purchased insurance were more

crops on fields that would not otherwise

likely to also produce soybeans but less

be considered for that crop because of

likely to produce forage crops. Young,

the potential for significant losses. More

Vandeveer and Schnepf (2001) found

generally, by removing the potential for

small positive production effects of crop

large losses from low prices or low yields,

insurance. Goodwin, Vandeveer and Deal

crop insurance, and especially revenue

If subsidized insurance changes decisions

(2004) found that a 30 percent decrease

insurance, causes additional production

about what mix of crops to grow, where

in premium costs caused less than a 1

of covered crops, especially in risky areas.

to plant them, and/or the process to

percent increase in Midwest corn acreage

Such effects may follow from risk aversion

produce them, it can affect land use and

and about a 1 percent increase in Northern

on the part of growers or the costs of

Plains barley acreage. The production

Effects of Subsidized Crop Insurance on Production and the Environment

environmental quality.

1

The differences among the crops are to be expected and reflect the variability of the agro-climate where the crops are grown and the degree to which production of a given crop is concentrated geographically. It is also worth noting that program cost varied little by level of aggregation for rice because its yield variability is low since almost all acres of rice are irrigated.

Economic and Environmental Effects of Agricultural Insurance Programs

11

impacts measured by these studies are

changed crop mix, finds increased

likely to be small for three reasons. First,

chemical use overall as a result of the

acreage choices in the Midwest are limited

crop mix change.

by rotational considerations and by the lack of land available for expanding on the extensive margin. Second, impact of crop insurance on acreage choices in the Midwest and Plains states are further reduced because crop insurance is generally available for all relevant alternative crops. The impact may well be larger for other crops in regions with more diverse cropping alternatives. Third, the research preceded the recent expansion of the crop insurance program. No studies have directly analyzed the effects of crop insurance on yield. However, a few papers have considered the impact of crop insurance on input use (see review in Glauber 2004). Horowitz and Lichtenberg (1993) suggested that crop insurance may be a substitute for risk-reducing chemicals—a moral hazard response. Babcock and Hennessey (1996) and Smith and Goodwin (1996) report small positive effects of yield insurance on input use, during a period of time when subsidies were low and revenue insurance was uncommon—so these can be considered conservative compared with today’s higher subsidization rate. Babcock and Hennessy find that crop insurance is a substitute for farm chemical use so that on a per-acre basis, chemical use declines on insured cropland. However, Wu’s (1999) study that showed that crop insurance

LaFrance, Shimshack and Wu (2002)

Lands brought into or retained in cultivation due to

simulated the effects of a variety of

these crop insurance

different insurance options. They conclude

subsidy increases

that “Land use is unchanged only when an actuarially sound and (unsubsidized) insurance contract is offered.” They go on to show that the increase in acreage

are, on average, less productive, more

devoted to crop production is on more

vulnerable to erosion

economically marginal land, especially

and more likely to

when the cost of insurance is subsidized. Lubowski, et al. (2006) used historical

include wetlands and

data on crop insurance program

imperiled species

participation and land uses to test

habitats than cultivated

the relationship between insurance subsidization and land use. They conclude

cropland overall.

that “Increased crop insurance subsidies in the mid-1990s motivated farmers to expand cultivated cropland area in the contiguous 48 states by an estimated 2.5 million acres (0.8 percent) in 1997, with the bulk of this land coming from hay and pasture. This land-use change increased annual wind and water erosion by an estimated 1.4 and 0.9 percent, as of 1997. Their empirical findings also substantiate LaFrance, Shimshack and Wu’s assessment that “… lands brought into or retained in cultivation due to these crop insurance subsidy increases are, on average, less productive, more vulnerable to erosion and more likely to include wetlands and imperiled species habitats than cultivated cropland overall.”

Economic and Environmental Effects of Agricultural Insurance Programs

12

Although the results are not definitive,

Net insurance payment is the difference

Less information is available about the

economics studies suggest that insurance

between insurance payments made to

distribution of benefits across farm size

subsidies shift land into crops that have

farmers of a crop and the insurance

categories. Unlike the standard farm

subsidized insurance and expand acreage

premiums paid by the farmers. The ratio

commodity subsidy programs, payment

generally and, specifically, on marginal

was calculated for each crop year from

and revenue limits do not apply to crop

lands that pose greater environmental

2001 through 2011 and averaged. These

insurance subsidies. That means large

threats.

ratios differ substantially across crops. For

operations are eligible for subsidized

2001 to 2011, the ratio was less than

insurance on all their acreage. Some

Distribution of Crop Insurance Subsidies

1.5 percent for rice, corn and soybeans;

policy advocates express concern that

between 3.3 percent and 4.3 percent for

large farms get large benefits from

Crop insurance benefits differ across farms

peanuts, barley and oats; and greater than

crop insurance subsidies. Nevertheless,

by which crops are produced, how the

5.5 percent for wheat, cotton and sorghum

no empirical evidence exists that crop

crop is marketed and other characteristics.

(see Figure 5). First note that all these

insurance subsidies affect the farm size

To consider the distribution across crops,

ratios are well above 1.0. The range across

distribution.

(Figure 5) expresses net insurance

crops underscores just how much crop

payment per insured acre as a ratio to the

insurance has benefited some major field

national average of gross revenue per acre.

crops relative to others.

Advocates note that crop insurance subsidies are more available for standard crops grown in conventional ways in core production regions than for specialty and small acreage crops grown in outlying regions, for organic crops, and for crops

Figure 5 Average Net Insurance Payment as a

with emerging or rapidly changing markets.

Share of Gross Receipts Per Acre by Crop for Major Field Crops, U.S., 2001-2011

Recent farm bills and other legislation have contained provisions that direct RMA to analyze the creation of crop insurance

Sorghum

7.6%

Cotton

7.0%

Wheat

5.5%

Oats

4.3%

Barley

4.1%

Peanuts

3.3%

Soybeans Corn Rice

1.5% 1.2% 0.9%

contracts for these types of commodities. The actuarial insurance concern and associated federal budget concern is that it is more difficult and costly to set appropriate premium rates for commodities for which there is less production history and for which there are few growers. Thus, costs of offering policies are likely to be higher and confidence is lower that premiums are correct. These considerations are highlighted by Singerman, Hart and Lence (2011) in their assessment of developing insurance products for

Source: Calculated using data from U.S. Department of Agriculture, Risk Management Agency, Summary of Business Reports and Data, available at http://www.rma.usda.gov/data/sob.html.

Economic and Environmental Effects of Agricultural Insurance Programs

organic crops.

13

Economic reasoning

Crop Insurance Subsidy and World Trade Organization Obligations

and those that are likely to prevail after the especially prominent role. This prominence

and empirical analyses

The 1994 WTO Agreement on Agriculture

makes crop insurance subsidies more

strongly suggest

(in Annex 2 paragraph 7) lists the

vulnerable to potential challenge, especially

characteristics of crop insurance programs

as crop insurance subsidies have increased

that crop insurance

that would be “at most minimally trade

in recent years.

distorting.” The basic criteria require that

2012 Farm Bill, crop insurance will have an

subsidies encourage production changes

losses must be large (at least 30 percent)

Summary and Conclusions

before compensation is made. U.S. crop

Economic reasoning and empirical

insurance programs do not meet these

negative environmental

analyses strongly suggest that crop

requirements. However, the cap on overall

insurance subsidies encourage production

effects of farming.

WTO commitment for U.S. farm subsidies

changes that increase aggregate negative

The production

is unlikely to be binding in the near future,

environmental effects of farming. The

so the failure of U.S. crop insurance to

production changes themselves may

changes themselves

meet “green box” criteria is unlikely to be

be relatively small for some crops but

of significant concern under the 1994

because insurance encourages planting on

agreement.

marginal lands the environmental impacts

subsidies are very small and percentage

Of perhaps more concern is that WTO agreements specify that government subsidy programs (for agriculture or other products) may not significantly suppress prices or similarly distort market conditions from what would otherwise be available. If the set of U.S. farm subsidies for a commodity, including crop insurance, increases U.S. production and thereby reduces imports, increases exports or suppresses market prices, then other WTO members may have grounds to win

that increase aggregate

may be relatively small for some crops but

are disproportionately high. The relatively

because insurance

few empirical studies on this relationship

encourages planting

generally date to an earlier time when crop insurance was a smaller program

on marginal lands the

with a lower degree of subsidization. Thus,

environmental impacts

they may understate the effects that the subsidization of programs has in 2012, with a larger, more diversified set of insurance programs at higher subsidy rates.

are disproportionately high.

More academic research of this issue at regional or national levels and with more current data is needed.

a formal complaint. The market effects

More research is also needed to measure

of U.S. subsidies constituted one core

the extent to which farmers respond to

complaint in the WTO dispute over U.S.

crop insurance subsidies by taking on more

cotton subsidies that the United States

risk elsewhere in their operation, such as

lost in several rounds of legal decisions

by shifting to cash rents or practicing less

and appellate body rulings from 2003

diversification.

through 2010. Under current conditions

Economic and Environmental Effects of Agricultural Insurance Programs

14

Crop insurance subsidies are now thoroughly embedded within much of crop agriculture, especially the program crops, and farmers would confront adjustment costs if Congress reduced or eliminated

The academic literature contains many

Given rising budget costs, effects

studies that examine insurance ratings

on production and environmental

issues, in particular the appropriate

consequences, the threshold question

yield distribution, and other program

remains what convincing public policy

operation issues, as well as the choice of

rationale exists for the use of taxpayer

insurance between individual and county

funds to cover crop insurance premiums,

insurance and the impact of premiums

administration and operation costs for

on the demand for insurance. However,

delivery of insurance by private companies

the academic literature remains limited

or the reinsurance for potential losses by

on issues such as the role of systemic

insurance companies? Risk management

risk, explanation of different payment

is inherent in all sound business plans,

rates across crops, and the potential

whether in farming or other industries,

consequences of payment limits.

and most farms use forward contracts, futures markets, diversification and/

In the debate over the 2012 Farm Bill,

or myriad other risk mitigation or risk

commodity groups have favored replacing

management practices and tools. Of

payments tied to planting history and

course, crop insurance subsidies are now

market price with payments triggered by

thoroughly embedded within much of crop

area-wide revenue shortfalls for program

agriculture, especially the program crops,

crops. Researchers have yet to consider

and farmers would confront adjustment

many issues about such programs, but it

insurance programs

costs if Congress reduced or eliminated

has been established that the cost of such

the programs now. However, while the

may provide a political

programs is inversely related to the extent

long history and recent growth of crop

of geographical area used to determine

reason for maintaining

insurance programs may provide a political

shortfalls.

reason for maintaining the programs, they

the programs now. However, while the long history and recent growth of crop

the programs, they do not provide an economic rationale.

Economic and Environmental Effects of Agricultural Insurance Programs

do not provide an economic rationale.

15

References and Data Sources Babcock, B.A., and D.A. Hennessy. 1996. “Input Demand Under Yield and Revenue Insurance.” American Journal of Agricultural Economics 78(3):416–27. Dismukes, Robert, Keith H. Coble, David Ubilava, Joseph C. Cooper, and Christine Arriola. “Alternatives to a State-Based ACRE Program: Expected Payments Under a National, Crop District, or County Base.” U.S. Department of Agriculture, Economic Research Report No. (ERR-126) 42 pp, September 2001. Accessed June 28, 2012 at http://www.ers.usda.gov/publications/err-economic-research-report/err126.aspx. Glauber, Joseph W. “Crop Insurance Reconsidered.” 2004. Am. J. Agr. Econ. 86(5): 1179-1195. Glauber, Joseph W. 2007. “Double Indemnity: Crop Insurance and the Failure of U.S. Agricultural Disaster Relief Policy.” Agricultural Policy for the U.S. Farm Bill and Beyond. Bruce Gardner and Daniel A. Sumner Editors. American Enterprise Institute. Washington, D.C. (2007). Goodwin. Barry K. 2001. “Problems with Market Insurance in Agriculture.” Am. J. Agr. Econ. 83(3): 643-649. Goodwin, Barry K. and Vincent H. Smith. 1995. The Economics of Crop Insurance and Disaster Relief. American Enterprise Institute, Washington, D.C. Goodwin, B.K., M. L. Vandeveer, and J. Deal. 2004. “An Empirical Analysis of Acreage Effects of Participation in the Federal Crop Insurance Program.” American Journal of Agricultural Economics 86:1058–1077. Halcrow, Harold G. 1949. “Actuarial Structures for Crop Insurance.” Journal of Farm Economics 31: 418–43. Horowitz, John K. and Erik Lichtenberg. 1993. “Insurance, Moral Hazard, and Chemical Use in Agriculture.” Am. J. Agr. Econ. 75(4): 926-935. Knight Thomas O. and Keith H. Coble. 1997. “Survey of U.S. Multiple Peril Crop Insurance Literature Since 1980.” Review of Agricultural Economics. 19(1): 128-156. LaFrance, J.T., J.P. Shimshack, and S.Y. Wu. 2002. “Crop Insurance and the Extensive Margin.” World Congress of Environmental and Resource Economists, AERE/EAERE, 2002. Lubowski, Ruben N. Shawn Bucholtz , Roger Claassen, Michael Roberts, Joseph Cooper, Anna Gueorguieva and Robert Johansson. Environmental Effects of Agricultural Land-Use Change: The Role of Economics and Policy. USDA Economic Research Service. Economic Research Report No. (ERR-25) 82 pp, August 2006. http://www.ers.usda.gov/publications/err-economic-research-report/err25.aspx. Mahul, O. 1999. “Optimum Area Yield Crop Insurance.” American Journal of Agricultural Economics 81(1):75–2. Miranda, M.J. 1991. “Area–Yield Crop Insurance Reconsidered.” American Journal of Agricultural Economics 73:233–42. Miranda, M.J., and J.W. Glauber. 1997. “Systemic Risk, Reinsurance, and the Failure of Crop Insurance Markets.” American Journal of Agricultural Economics 79:206–15. Nelson, C.H., and E.T. Loehman. 1987. “Further Toward a Theory of Agricultural Insurance.” American Journal of Agricultural Economics 69:523–31. Shields, Dennis A. Congressional Research Service. 2010. “Federal Crop Insurance: Background and Issues.” Dec. 13, 2010. http://www. nationalaglawcenter.org/assets/crs/R40532.pdf. Singerman, Ariel, Chad E. Hart and Sergio Lence. 2011. “Price Analysis, Risk Assessment, and Insurance for Organic Crops.” (August) CARD Policy Brief 11-PB 6. http://www.card.iastate.edu/publications/dbs/pdffiles/11pb6.pdf. Skees, J.R., J.R. Black, and B.J. Barnett. 1997. “Designing and Rating an Area Yield Crop Insurance Contract.” American Journal of Agricultural Economics 79, 430-438. Smith, V.H. and V.K. Goodwin. 1996. “Crop Insurance, Moral Hazard and Agricultural Chemical Use.” American Journal of Agricultural Economics. 78: 428-438. Smith, Vincent H. 2011. “Premium Payments Why Crop Insurance Costs Too Much.” American Enterprise Institute. http://www.aei.org/ files/2011/11/04/-premium-payments-why-crop-insurance-costs-too-much_152221377467.pdf.

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Economic and Environmental Effects of Agricultural Insurance Programs

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